Speculation is not manipulation

In the fine tradition of Thomas Malthus, famous Stanford finance professor Darrell Duffie has penned an op ed entitled "In Defense of Financial Speculation: It is not the same thing as market manipulation." He has a sharp mind and makes the case well.

First, speculators perform valuable market functions by taking risk and disseminating information (remember Enron?).

Speculators earn a profit by absorbing risk that others don't want. Without speculators, investors would find it difficult to quickly hedge or sell their positions.

Speculators also provide us with information about the fundamental values of investments. When the fundamentals appear favorable, they buy. Otherwise, they sell. If their forecasts are correct, they profit. This causes prices to more accurately forecast an investment's value, spreading useful information. For example, the clearest evidence that Greece has a serious debt problem was the run-up of the price for buying CDS protection against the country's default.

Is this sort of speculation wrong? I have not heard why.

The distinction between "speculation" and "manipulation" is important.

Those who call for stamping out speculation may be confused between speculation and market manipulation. Manipulation occurs when investors "attack'' a financial market in order to profit by changing the value of an investment. Profitable speculation occurs when investors accurately forecast an investment's fundamental strength or weakness.

Manipulation is much harder to pull off than making a simple directional bet.

Market manipulation for profit is not easily done... Simply driving up the price, as speculators are alleged to have done in the oil market in 2008, is not enough. To make a profit, a manipulator needs to obtain monopolistic control of the supply. Given the size of the oil market, that seems implausible, absent a major and sustained conspiracy.

As long as speculators do not crash and destabilize financial markets with them, they are not where regulatory attention should lie.

It would be better for our economy to enforce anti-manipulation laws, and require that speculators have enough capital to cover their risks, than to attempt to squash speculation.

Worth keeping in mind the next time someone starts ranting about "reckless speculation."